Analysis: Even though they’ve rebounded, U.S. shares outperform in the long run

Starting in the spring, emerging markets stocks have staged a stealth rally. The average emerging markets equity fund has risen 6.1% since the beginning of April, while the average U.S. stock fund is up 3.6%, according to TrimTabs Investment Research.

Investors have responded as they usually do: by chasing performance. After having pulled $11.6 billion from EM stock exchange traded funds from January to March, “the tide really began to turn. Lately investors have been buying emerging markets,” TrimTabs CEO David Santschi says.

They’re likely chasing rainbows again.

As I’ve written here, here and here, people invest in emerging markets on a demonstrably false premise: that higher economic growth leads to higher stock market returns. The evidence is clear that stock market returns don’t have much to do with GDP growth.

Also, leading emerging market mutual funds and ETFs are heavily weighted towards the BRIC countries (Brazil, Russia, India and China), three of which are in secular bear markets. (Only India is still in a long-term bull market.) The two largest emerging market ETFs have more than 40% of their holdings in the BRICs.

And the U.S.’s huge debt load and the Federal Reserve’s massive bond buying have prompted some investors (mostly hard-money libertarians) to abandon U.S. stocks for emerging markets, whose monetary policies they deem more sound.

This position, which seems as much political as economic, is advocated by doom-and-gloomer Peter Schiff, among others.

How’s that working out? Not great. U.S. stocks have vastly outperformed emerging markets for the past two, three and five years.

That shouldn’t be surprising. During that time, researchers have found far more evidence that emerging markets aren’t the super performers so many investors still think they are.

Early this year, three of the world’s leading experts on equity returns — Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School — built a new index of long-term emerging markets stock performance for Credit Suisse’s 2014 Investment Returns Yearbook.

They found that developed markets actually beat emerging markets by 8.3% to 7.7% a year from 1900 through 2013. (Since 1950, however, EM have outperformed developed markets by 12.5% to 10.8% annually.)

EM stocks also are much more volatile than either the U.S. or other developed markets. According to Morningstar, over a 10-year period, EM stocks have a standard deviation of 23.9, 30% higher than developed market stocks and 60% more variable than the S&P 500 Index.

A new white paper published by BlackRock looked at 10 major emerging economies and found that since 1992, emerging stock markets, on average, captured only 73% of the GDP growth of their host countries. So, if an economy was growing by, say, 8% a year, its stock market returned only 5.8% to investors.

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